1. Field of Invention
The present invention relates to a method of matching buyers, particularly buyers of smaller amounts, and sellers of fixed income securities at different prices and commissions for like maturities, specifically, but not exclusively, municipal bonds, over electronic networks, specifically, but not exclusively, the Internet.
2. Description of the Prior Art
Primary Market
An example of the prior art process is shown in FIG. 1 and the tables below. In FIG. 1, issuers (A1) offer bonds for sale to a broker dealer acting as an underwriter (A2) either through a competitive or negotiated process. This prior art process requires that personnel at the syndicate desk (B2) of the underwriter (A2) communicate (either telephonically or by facsimile) the pricing to personnel at retail trading desks (C2, C3) at both the underwriter and at other brokerage firm(s) (Row C) in the selling group. This pricing information typically includes the coupon, maturity, price, yield and commission for each separate security of the fixed income debt instrument issued. A sample of typical pricing information follows as Table 1:
TABLE 1Pricing SheetMaturitySalesJanuary 1PrincipalCouponYieldPriceCommission2002100,0005.10%5.15%0.999520.2502003200,0005.20%5.20%1.000000.2502004300,0005.30%5.35%0.998630.3752005400,0005.40%5.45%0.998220.3752006500,0005.50%5.55%0.997840.3752007600,0005.65%5.60%1.002510.6252008700,0005.75%5.70%1.002850.6252009800,0005.85%5.85%1.000000.6252010900,0005.95%6.00%0.996560.500
Fixed income debt instruments are often structured with multiple maturing securities, with each individual security having a common coupon and maturity date and identified by a separate CUSIP (Committee on Uniform Securities Identification Procedures) number. The pricing information includes the amount of the primary market sales commission for each individual security. Current market practice suggests that each originally issued security offered in the primary market be sold at the same price regardless of the size of the order. The individual securities identified by a like CUSIP are also often sold to different types of buyers in both larger institutional and smaller retail denominations. Retail trading desks usually use sales assistants to contact the retail brokers (Row D of FIG. 1) who then solicit retail investors (Row E) for orders. This prior art system is extremely labor-intensive, with several steps requiring human interaction that add time and cost to the overall sale process. Since primary market sales commissions are generally not sufficient to compensate retail brokers to complete this process for smaller, retail orders, the fixed income market (specifically, but not exclusively, the municipal bond market) has developed a process using the secondary market that completes those sales. As a result of this process, most retail investors purchase fixed income securities through brokers, however, more often in the secondary market than in the primary market.
Secondary Market
The inefficiency of the prior art process is demonstrated by the example that over 34% of all municipal bonds outstanding are held by retail investors (Federal Reserve Board, Flow of Funds Accounts, Flows and Outstandings, First Quarter, 2000) while research indicates that only 12.5% of the bonds are initially sold to retail investors at the initial re-offering prices (primary market). The remaining 21.5% of municipal bonds reach the retail investor during the first six months after issuance in the secondary market. A major barrier to effective retail distribution of originally issued fixed income securities, particularly but not exclusively, municipal bonds, has been the inability, given brokerage firm cost structures, for retail brokers to write a ticket for a small purchase of bonds during the initial offering period. The median size purchase of municipal bonds in the market is $25,000, which clearly indicates strong retail trading in the market.
Primary market sales commissions (generally between 0.25% and 0.50% of the par amount) generate between $62 and $125 for $25,000 orders. These commissions are not competitive with other financial products offered by brokerage firms to their retail clients, including secondary market municipal bonds. Under current industry practice, broker-dealers or institutional investors purchase primary market bonds from underwriters and convert higher yields (in the form of original issue discount or coupon payments) into commission dollars in the secondary market by marking up the price of the bonds. After the markups, retail brokers redistribute the bonds to retail investors with higher commissions.
Table 2 shows an example of the existing prior art process using the secondary market.
TABLE 2Existing ProcessSalesProceeds fromOrderPriceYieldCommissionSale of BondsSize($)(%)(%)%Dollars%DollarsPrimary MarketA1100,00098.505.70.5050098.0098,000B120,00098.505.70.5010098.0019,600Secondary MarketB220,00099.005.651.00200XB310,000100.005.551.00100YB410,000100.505.501.50150This example assumes that the retail investors shown in line X and Y each want $10,000 of municipal bonds. The issuer sells $120,000 of bonds that are initially offered for sale to the public by the underwriter at a price of 98.50%, which reflects an “original issue discount” of 1.50%. In addition, the underwriter charges the issuer a sales commission (or underwriting fee) of 0.50%. The issuer's total cost is 5.75%. The prior art process includes the same sales commission for an order that would be obtained from a typical institutional investor (shown on line A1 of Table 2) or from a typical retail investor (shown on line B1 of Table 2).
Under the prior art process, retail brokers are unlikely to submit the $10,000 orders in the primary market because the sales commissions are lower than commissions paid on other investments. In this example, the underwriting firm received no retail orders for the bonds on Line B1 of Table 2 and decided to sell the bonds to another brokerage firm in the secondary market, as shown on Line B2 of Table 2. The underwriter increased the price of the bonds (see FIG. 2) $100 to increase the commission and thereby lowered the yield to 5.65%. This resulted in commissions of $200 to the underwriter, or twice as much as the firm would have made by selling the bonds in the primary market to retail investors. The brokerage firm then resells $10,000 of the bonds to a retail investor (X) at a yield of 5.55% and earns an additional $100 in sales commissions, as shown on Line B3 of Table 2. The same brokerage firm resells the other $ 10,000 to another retail investor (Y) at a yield of 5.50% and earns an additional $150, as shown on Line B4 of Table 2. The total cost of distributing this $20,000 in bonds to retail investors was $450 or 2.25% of the amount of the bonds sold. The issuer paid all of these costs, which included $ 100 as disclosed initially in an underwriting fee and $350 in the form of the higher yield of 5.70%.
Secondary market markups are a cost not just to the retail investor, but also to the issuer of the municipal bonds. The existence of this inefficient distribution system creates more profit (and risk) for financial intermediaries at the expense of both issuers and investors. Known patents in the field include U.S. Pat. Nos. 5,809,483; 5,915,209; 6,161,099 and 6,236,972.